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Canadian Real Estate Investment Trusts (REITs) aren’t for everybody. But for some, they’re a blessing in disguise.
You may know someone who vows to stay away from anxiety-inducing equities and to stick with real estate. Such investors seek comfort in owning tangible assets that provide them with a fixed monthly rent.
But others find direct investments in real estate to be cumbersome. After all, real estate is illiquid and requires active management.
Enter REITs (pronounced “reets”), a middle ground that gives investors wary of illiquidity an opportunity to invest in real estate without having to actively manage properties or invest a large amount of capital.
What Are REITs?
REITs are companies that own and often operate income-generating real estate. Think of them as a mutual fund that holds real estate instead of equities or bonds. (To learn more about mutual funds, check out this MoneyWizard guide.)
REITs are actively managed by industry professionals who identify opportunities and invest in commercial real estate. REITs lease these properties to generate rental income.
In addition to the rental income, REITs also benefit from capital gains if the value of the owned properties appreciates over time.
How Do REITs Work?
As an investor, you can buy units of a REIT from an exchange. Owning these units entitles you to part ownership of the properties owned by the REIT and to collect a part of its rental income.
Some REITs invest your funds in a single sector of real estate, such as healthcare, infrastructure, apartment buildings, and office complexes. Other REITs diversify by investing in several sectors of real estate.
REITs must pay out a minimum of 90 percent of their taxable income to investors. This makes them a convenient fixed-income investment vehicle if you want a steady source of income.
Some REITs—mortgage REITs—also finance real estate purchases instead of investing in them. Speaking of which . . .
Types of REITs
What we have discussed thus far are equity REITs. Although they are the most popular type, there are other types of REITs you can invest in.
Equity REITs purchase properties and lease them to tenants. Rental income is the primary source of income for equity REITs, but not the only one. REITs can also earn capital gains as a result of appreciation in the prices of the properties they own.
Equity REITs pay out most of their earnings to shareholders after deducting management and operating expenses. The standard practice for US-based REITs is to distribute earnings quarterly, but Canadian REITs distribute earnings monthly.
The primary difference between mortgage REITs (mREITs) and equity REITs is that the latter directly hold and manage properties, whereas mREITs hold mortgages on real estate purchased by some other entity.
An mREIT behaves more like a financier than an investor. This fact makes its business model a little more complex than the business model of an equity REIT.
Because mREITs own no real estate, you won’t benefit from any appreciation in real estate prices by participating in this investment vehicle. An mREIT is also more sensitive than an equity REIT to fluctuations in the interest rate.
Let’s consider an example of a mortgage REIT.
Let’s say that a mortgage REIT pools $5 billion from investors and borrows an additional $10 billion at 4 percent from other sources. It buys $15 billion worth of mortgages that have a 6 percent yield. So:
|Interest Paid||$400 million ($10 billion x 4 percent)|
|Interest Earned||$900 million ($15 billion x 6 percent)|
|mREIT annual income||$500 million|
|mREIT annual return||10 percent|
This is a simplified example that does not take into account the management, operating, and other expenses of the REIT. In any case, mREITs tend to be riskier than equity REITs and offer higher potential return.
Hybrid REITs are a combination of equity REITs and mortgage REITs. They purchase real estate as well as mortgages and earn rental income as well as interest income. Generally, hybrid REITs allocate most of their capital to one type of investment or the other, i.e., to real estate or to mortgages.
REITs can also be categorized with respect to their sector and trading status. The most common sectors that REITs invest in are hospitality, retail, residential, healthcare, and office. The three main categories with respect to trading status are:
- Publicly Traded REITs. These are the most popular kind of REIT to invest in. They are listed on a securities exchange like TSX, where retail investors can buy and sell them in real time. Publicly traded REITs are very liquid. They enable investors to gain real-estate exposure without investing large funds in illiquid property.
- Public Non-traded REITs. Although public non-traded REITs can be traded by the public, they aren’t listed on a stock exchange. Although they are not as liquid as publicly traded REITs, they tend to offer more stability since they remain unaffected by market volatility.
- Private REITs. These REITs are unavailable to retail investors. A risky and expensive affair, private REITs are accessible only to qualified investors.
Pros of Investing in REITs
Investing in REITs offers unique benefits.
REITs were created to give retail investors access to a class of assets otherwise out of their reach. How many of us can purchase an office at the Scotia Plaza or even at a much smaller commercial complex?
Thankfully, we now have REITs, which enable us to invest in pieces of properties throughout Canada and to earn rent from them.
If you’ve ever sold a property, you know how illiquid real estate can be, especially in a difficult market. REITs eliminate this obstacle. Publicly traded REITs can be bought and sold in real time through exchanges. If you ever need the money that you have invested in a REIT, you can redeem it with the click of a button.
Exemption from Corporate Tax
When you put your money in dividend stocks, your earnings are taxed twice: once when they’re earned by the corporate entity, again when they’re paid out to you as dividends. REITs pay zero tax regardless of their profitability so long as they pay out all of their earnings as dividends.
Benefits of Diversification
Adding REITs to your portfolio can reduce its overall risk. Without access to REITs, most small investors could not have used real estate to diversify their portfolios. REITs facilitate diversification by allowing small-ticket investment in real estate.
Steady Stream of Income
All REITs pay at least 90 percent of their taxable income to their shareholders. This usually means a dividend yield that is higher than the yield of good old dividend stocks on the TSX. You can earn a steady income with REITs or even reinvest the dividends to compound their value over time.
Potential for High Returns
Dividends are not the only way that REITs generate earnings; they can also enjoy capital gains. As the value of properties held by a REIT appreciates, it can sell the properties to realize capital gains and reinvest the proceeds. Some REITs even develop properties themselves.
Capital gains plus dividends add up to returns that are nothing to sneeze at. Some REITs have even managed to consistently beat the market over the past three decades.
Cons of Investing in REITs
REITs are an excellent investment vehicle. But to safeguard your capital and maximize your returns, you should keep in mind the downsides of this form of investment.
More Suitable for Long-Term Investors
Although REITs are highly liquid, you should not invest money in them that you need in the short term. Like equities, real estate has good times and bad. Liquidating your investments in the short run could erode your capital. Ideally, you should invest money that you won’t need for at least the next five years—and the longer the better.
Sensitive to Fluctuations of the Interest Rate
It’s a common misconception that REIT stock prices and interest rates are inversely correlated. Sometimes this is true, but not always. The relationship is a little more complex.
The data suggest that REIT stock prices and interest rates are positively correlated in a growing economy and negatively correlated in a slowing economy. When you invest in a REIT, you should monitor interest rates and other macroeconomic indicators to analyze how they may affect the value of the REIT.
Although the REIT itself can dodge the tax bullet, the income of shareholders will be taxed. The distributed earnings are added to your tax return as income from property and will be taxed at the ordinary rate of tax. This is why it’s advisable to hold REITs within a tax-deferred account like a TFSA or an RRSP.
REITs also tend to be less tax-efficient than actively managed real estate. To lower your taxable income, you can claim depreciation from year one, along with other management expenses.
REITs are a great way to diversify your portfolio. But investing in only a single REIT may leave you exposed to sector-specific risks. Most REITs allocate a large part of their holdings to a single sector, like hospitality or retail. But hospitality REITs are much more sensitive to economic downturns than residential REITs. When you invest in both types of REIT, you lower your overall risk.
Reasons to Invest in REITs
REITs can give your portfolio the muscle to weather an economic slowdown. You’ll be able to invest in real estate without the hassle of maintaining an immovable property and without having to commit a large amount of money.
If you’re a long-term investor with adequate surplus funds, you should consider investing in a REIT. You should also be aware of the risks before you invest. But if you already have equity, debt, and gold in your portfolio and you’re ready to diversify further, the investment opportunity that REITs offer is a compelling one.
Frequently Asked Questions
Should I invest in REITs during a recession?
REITs strengthen your portfolio with steady cash flows and are more resilient during a recession than stocks. If prices of fundamentally strong REITs plunge during a recession, this may be a good opportunity to invest in them. Regardless of economic conditions, though, a REIT provides ample benefits for investors.
How risky are REITs?
Investing in REITs comes with several risks, especially market risk; REITs tend to be highly sensitive to changes in the interest rate. Another risk is an overleveraged balance sheet. REITs borrow money to purchase properties. If they borrow too much, financial distress may result. REITs are also vulnerable to sector-specific risks. During a pandemic, for example, the value of a hospitality REIT may depreciate significantly more than the value of a residential REIT.
How do I invest in REITs?
You can invest in a publicly traded REIT the same way you invest in a stock. REITs are listed on the TSX. You can also purchase a REIT mutual fund or a REIT exchange-traded fund (ETF) using your online brokerage account.
Alternatively, you can invest in a public non-traded REIT by directly purchasing units from the REIT company. Private REITs, however, accept funds only from accredited investors.
What is a REIT and why is it a desirable investment? ›
REITs are true total-return investments. They provide high dividend yields along with moderate long-term capital appreciation. 4 Look for companies that have done a good job historically at providing both. Unlike traditional real estate, many REITs are traded on stock exchanges.What are the advantages of a real estate investment trust? ›
REITs have historically provided investors dividend-based income, competitive market performance, transparency, liquidity, inflation protection and portfolio diversification. REITs offer investors the benefits of commercial real estate investment along with the advantages of investing in a publicly traded stock.What is the main objective of investing in REITs? ›
The objective of REITs is to provide investors with dividends generated from capital gains accruing from the sale of commercial assets the REIT invests in. The trust distributes 90% of the income among its investors via dividends, thereby passing on its tax burden to shareholders.What are the pros and cons of a real estate investment trust? ›
The benefits of a REIT investment include liquidity, diversification, and passive income in the form of high dividends. The potential downsides of a REIT investment include taxes, fees, and market volatility due to interest rate movements or trends in the real estate market.Why should you invest in real estate? ›
The big goal of real estate investing is to increase your cash, otherwise known as building capital. When you sell a property that has risen in value, you'll boost your capital. The key, of course, is to invest in the right properties that will rise in value.Why do REIT investments make sense? ›
Through a share offering, a REIT lets investors own its assets at a fraction of a cost. Since 75 percent of a REIT's total assets are mandated to be invested in income-generating property, you are most likely guaranteed returns via dividend yields.Is real estate investment trust worth it? ›
Steady dividends: Because REITs are required to pay 90% of their annual income as shareholder dividends, they consistently offer some of the highest dividend yields in the stock market. That makes them a favorite among investors looking for a steady stream of income.How does a real estate investment trust work? ›
Most REITs have a straightforward business model: The REIT leases space and collects rents on the properties, then distributes that income as dividends to shareholders. Mortgage REITs don't own real estate, but finance real estate, instead. These REITs earn income from the interest on their investments.How does a real estate investment trust make money? ›
REITs make their money through the mortgages underlying real estate development or on rental incomes once the property is developed. REITs provide shareholders with steady income and, if held long-term, growth that reflects the appreciation of the property it owns.Why are REITs important? ›
REITs own, operate, and develop traditional commercial properties like shopping centers, office buildings and apartment complexes, but also more specialty properties, such as cell towers, self-storage facilities and healthcare clinics.
How do you make money from a REIT? ›
Another way to make money from REITs is to buy REIT shares at a low price and then sell them later at a higher price. Considering that the value of properties increases over time, REIT share prices may also grow. This means a high earning potential for REIT shareholders.Are REITs a good investment for the future? ›
In contrast, REITs probably aren't a good investment if you're investing for the short-term since liquidity can be low. Additionally, since REITs must pay out at least 90% of income as dividends to shareholders, they don't typically have as much growth potential as growth stocks.What are the risks of investing in a REIT? ›
Compared to other investments such as stocks and bonds, REITs are subject to various risk factors that affect the investor's returns. Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.What are the risks of investment trusts? ›
What are the risks associated with an investment trust? Capital is at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.What are the three most important factors in real estate investments? ›
Expected cash flow from rental income (inflation favors landlords for rental income) Expected increase in intrinsic value due to long-term price appreciation. Benefits of depreciation (and available tax benefits)Why real estate is the safest investment? ›
Unlike other market-linked investment options such as stocks and mutual funds, investment in real estate comes with a low volatility quotient. Being a tangible asset, it is still one of the safest investment options in India.Can REIT make you rich? ›
REITs Are The Easiest, And Usually The Best, Way To Invest In Real Estate. While commercial real estate is where many of the world's millionaires and billionaires come from, you don't have to be a professional real estate developer to get rich from this sector.Is REIT high risk? ›
Like all equities, they carry a measure of risk that is much greater than government bonds. REITs can also produce negative total returns during times when interest rates are high or rising.Is a REIT as good as owning property? ›
REITs provide a much simpler way to invest in real estate and earn consistent income through dividends, but they confer less control, and their upside tends to be lower than that of rental properties.What is REIT and how it works? ›
When you invest in a real estate investment trust (REIT), your money is pooled together with other investors' in a collective investment scheme that invests in a portfolio of income generating real estate assets such as shopping malls, offices, hotels or serviced apartments.
Which REIT is best to invest? ›
- Claros Mortgage Trust Inc. (CMTG)
- Digital Realty Trust Inc. (DLR)
- Rayonier Inc. (RYN)
- Sabra Health Care REIT Inc. (SBRA)
- Stag Industrial Inc. (STAG)
- Ventas Inc. (VTR)
- Vici Properties Inc. (VICI)
- Vornado Realty Trust (VNO)
The two main types of REITs are equity REITs and mortgage REITs, commonly known as mREITs. Equity REITs generate income through the collection of rent on, and from sales of, the properties they own for the long-term. mREITs invest in mortgages or mortgage securities tied to commercial and/or residential properties.How much should I invest in real estate investment trust? ›
Private REITs may have an investment minimum, and that typically runs from $1,000 to $25,000, according to NAREIT, the National Association of Real Estate Investment Trusts.Can you become a millionaire from REITs? ›
For example, earning 11% annual total returns on a $300/month contribution would allow an investor to surpass $1 million after just 33 years. Setting aside $100 a month for each of these three real estate investment trusts (REITs) could make you a millionaire in the span of just over three decades.Do REITs pay monthly income? ›
Law requires that REITs pay required dividends at least once annually; however, many REITs pay quarterly or monthly. REIT investors should educate themselves on the payment schedule of a potential REIT investments before investing.Are REITs a good investment in 2022? ›
While REIT share prices have been in freefall throughout 2022, both the rents that REITs collect from their tenants and the dividends they pay out to shareholders have continued to improve. There are now a litany of high-quality REITs with excellent balance sheets that offer a high (and growing) yield.What to know before investing in a REIT? ›
When you're ready to invest in a REIT, look for growth in earnings, which stems from higher revenues (higher occupancy rates and increasing rents), lower costs, and new business opportunities. It's also imperative that you research the management team that oversees the REIT's properties.What is the average return on a REIT? ›
|Time period||S&P 500 (total annual return)||FTSE NAREIT all equity REITS (total annual return)|
|The last 20 years||7.7%||13.3%|
|The last 10 years||14.2%||13.2%|
|The last 5 years||12.5%||9%|
|The last year (2019)||31.5%||28.7%|
For example, certificates of deposit (CDs), money market accounts, municipal bonds and Treasury Inflation-Protected Securities (TIPS) are among the safest types of investments.What is a REIT and how does it work? ›
REITs, or real estate investment trusts, were created by Congress in 1960 to give all individuals the opportunity to benefit from investing in income-producing real estate. REITs allow anyone to own or finance properties the same way they invest in other industries, through the purchase of stock.
Is REIT a good investment option? ›
Since REITs are required to distribute nearly 90% of their earnings in the form of dividends to the REIT investors, they can be assured of a higher income ratio. This enhances the yield for investors in REIT funds. REITs are designed to be tax efficient. The government has given them pass-through status.What is a REIT and is it an important part of any investment portfolio? ›
A real estate investment trust (REIT) is a company that owns, operates, or finances income-producing properties. REITs generate a steady income stream for investors but offer little in the way of capital appreciation.Is REIT worth investing? ›
Why REITs make a good investment. REITs offer investors several benefits that make them an ideal fit in any investment portfolio. These include competitive long-term performance, attractive income, liquidity, transparency, and diversification.What is a REIT in simple terms? ›
REITs, or real estate investment trusts, are companies that own or finance income-producing real estate across a range of property sectors. These real estate companies have to meet a number of requirements to qualify as REITs. Most REITs trade on major stock exchanges, and they offer a number of benefits to investors.How do you make money from REITs? ›
Earning money from a publicly owned real estate investment trust (REIT) is like earning money from stocks. You receive dividends from the profits of the company and can sell your shares at a profit when their value in the marketplace increases.What REIT is the best to invest? ›
- Vanguard Real Estate ETF (VNQ)
- Vanguard Global ex-U.S. Real Estate ETF (VNQI)
- iShares Core U.S. REIT ETF (USRT)
- iShares Global REIT ETF (REET)
- Schwab U.S. REIT ETF (SCHH)
- Real Estate Select Sector SPDR Fund (XLRE)
- Direxion Daily Real Estate Bull 3X Shares (DRN)
Malls (-47.76%) and Infrastructure (-43.36%) REITs are the worst performing property types thus far in 2022. The REIT sector as a whole saw the average P/FFO (2022) decrease 2.2 turns in September (from 15.0x down to 12.8x).What are the risks of owning REITs? ›
Compared to other investments such as stocks and bonds, REITs are subject to various risk factors that affect the investor's returns. Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.